Three Stock Market Warning Signals to Look Out For

The stock market does not turn on a dime… at least historically that’s been the case. There was always a distinctive topping process going on before the bear finally struck. In every case you can look back and detect the same pattern: a marked deterioration of market internals and of interest rate based indicators before any crash so, if history is our guide, we should not expect this time to be different. So, what should we look for?

The comments above & below are edited ([ ]) and abridged (…) excerpts from an original article byClaus Vogt (moneyandmarkets.com)

I think chances are very good that we’ll get some of the typical indications of an imminent bear market before this medium-term up trend that began in March 2009 is over. To pick up on those indications when they start flashing warning signals of a trend change, I’m closely watching for deterioration in three major areas:

Warning Signal #1: Macro-Economic Deterioration
The Conference Board’s Index of Leading Economic Indicators (LEI) has an outstanding track record in giving warning signs of an imminent recession – and when it does, you can expect that a severe bear market is in the making. This indicator continues to rise and these strong readings signal a continuation of the economic rebound for at least another two quarters. No worries here.

Warning Signal #2: Monetary Deterioration
Interest rates and monetary growth have a huge influence on the stock markets and strongly rising rates are bearish, especially short-term ones and with the Fed making it clear that it will keep short-term interest rates very low for an “extended period of time” there is no warning signal here.

With long-term rates the picture is more problematic. 10-year Treasury bond yields have clearly risen from the panic lows reached in December 2008 and have trended sideways since then. Should 10-year Treasury bond yields rise above the June 2009 high of 4 percent for a few months, we can expect problems for the stock market – and I predict they will rise during the coming months. For the time being, however, no warning signal is being given.

As an answer to the crisis in 2008 the Fed started printing money like there was no tomorrow. Consequently, monetary aggregates skyrocketed with double digit year-over-year growth rates. Additional liquidity pushes prices up, which could fuel a bull market. However, this very high monetary growth has come down remarkably. This is an early warning sign, but not yet severe. The time lag between monetary changes and changes in the financial markets or even the economy are long. Only if the deterioration in monetary growth continues during the coming months would a clear warning signal be given.

Warning Signal #3: Technical Deterioration
There are many technical indicators to watch for a trend change. Four of the most important are:
1. the 200-day moving averages,
2. market breadth,
3. new highs and new lows, and
4. investor attitudes toward the market.
None have shown any signs of deterioration and, as such, these important technical indicators have not given any warning signals yet.

ConclusionAs mentioned in the opening paragraph there was always a distinctive topping process going on before the bear finally struck – a marked deterioration of market internals and of interest rate based indicators – but such have not happened to date but is something to watch out for in the months to come.

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